Non-Disclosure of Regulators' Concerns at Heart of Keating Case : Courts: Trial focuses on the failure of Lincoln's small investors to learn of the thrift's inadequate net worth.

LOS ANGELES — American Continental Corp. had barely begun selling bonds to small investors when thrift regulators told the company's chairman that the company's main unit, Lincoln Savings & Loan, was in shaky financial condition.

The news was delivered in businesslike fashion to the chairman, Charles H. Keating Jr., at a Dec. 5, 1986, meeting with regulators, said Michael Patriarca, who was in charge of the federal examiners then reviewing the Irvine thrift.

Patriarca, testifying in the criminal securities fraud case against Keating in Los Angeles Superior Court, said he was concerned that the company would not be able to repay the debt it was issuing because it had inadequate net worth, which is essentially assets minus liabilities.

Yet small investors who were buying the corporate bonds at Lincoln's Southern California branches were not told what regulators thought about the S&L's condition, and the company's sales force never got the word either. Rather, the message was that American Continental and Lincoln were rock-solid institutions.

So far, after 19 days of testimony from 27 prosecution witnesses, the failure to disclose those regulatory concerns is the heart of the case against Keating.

He is accused of defrauding 22 small investors--part of thousands who lost more than $250 million in the April, 1989, collapse of his financial empire--by making or causing false statements to be made and by omitting material information.

No one who has testified has linked Keating to any false statements, but former Lincoln Chairman Robin S. Symes, who has pleaded guilty to six securities fraud charges, testified that Keating never directed him to inform bond sellers and bond buyers of the issues raised at the meeting with regulators.

Patriarca testified that he raised his concern about Lincoln's inadequate net worth after Keating asked for approval for the S&L to pay a $20-million dividend to American Continental. Patriarca shot the request down.

"I said I had a problem with that because it appeared that Lincoln failed its net worth test," Patriarca testified. "I could not condone the payment of a dividend because it would reduce the net worth: Lincoln would lose its cushion against losses."

Keating's defense, so far, has challenged whether that omitted information was indeed material, especially since regulators later changed some figures, allowed Lincoln to pay dividends again and agreed that the S&L might actually have enough net worth.

Patriarca and other regulators admitted under cross-examination that the numbers used to calculate Lincoln's net worth in December, 1986, were preliminary and depended on the value assigned to various assets, including the luxurious, $296-million Phoenician Resort in Scottsdale.

A major loss at what regulators believed to be the S&L's biggest white elephant and the greatest point of contention between them and Lincoln could have wiped out the thrift's net worth at the time.

Keating has asserted that federal regulators, particularly those in San Francisco's regional headquarters, had a vendetta against him and were determined to find an excuse to shut him down. Symes testified that a federal examiner told him in May, 1986, that his superiors in San Francisco wanted him to redo his audit of the S&L and keep looking into Lincoln "until he found something."

As far as the bond sales program went, Keating's lawyer, Stephen C. Neal, told the jury in his opening statement six weeks ago that American Continental retained the best lawyers and accountants to structure the bond program and that Keating was committed to complying with the law, two major aspects of the defense strategy.

A bond seller, for instance, was fired for being too aggressive, and Symes and Ray C. Fidel, a former Lincoln president, were reprimanded for violating bond sale procedures.

Prosecutors have been hammering hard on the notice Keating had from regulators that his empire was crumbling. Alex Barabolak, a top examiner, testified last Wednesday that by the fall of 1988, American Continental was simply "pyramiding" debt upon debt and using the proceeds to buy stock from Keating and other insiders.

But Neal, who has been poking holes in testimony by prosecution witnesses, showed that it was an inverse pyramid. Barabolak's own report revealed that debt securities sold by American Continental actually reduced the company's overall borrowings by $546 million over five years. In addition, neither the company nor its employee stock ownership plan purchased stock from Keating after 1987.

The prosecution, however, doesn't believe that any of the defense's contentions mean a thing when it comes to deciding whether bond buyers should have been told about the thrift's financial troubles in late 1986 and early 1987.